Rules for Distribution in Companies – Limited Liability Companies and Partnerships

The primary purpose of establishing and operating a company is to make money. Thus, the rules regarding the participants' right to the company's assets are central to corporate law. This article provides a thorough introduction to the regulations related to distributions from companies, with a particular focus on private limited companies and public limited companies, but also with a look at partnerships. We go through the central concepts, the conditions for lawful distributions, and the consequences of rule violations.

Fundamental Differences Between Corporate Forms

There are different rules for distributions in private limited companies and partnerships. While the corporate legislation imposes extensive restrictions on the ability to distribute, in partnerships it is, in principle, almost completely free. This is directly related to the form of liability:

• In private limited companies, participants are indirectly and limitedly liable only up to their share contributions. The tied-up company capital thus functions as a "buffer" against distributions to ensure creditors get coverage.

• In partnerships, participants are personally liable for the company's obligations. Therefore, distributions that affect both equity and external capital may be made in principle, as long as it does not apparently harm the company's or creditors' interests.

A common feature of both corporate forms is the principle of equality:

• In private limited companies, all shares generally give equal rights to dividends (unless the articles of association establish different share classes).

• In partnerships, profits according to the default rule should be shared equally among the participants.

Distributions from Private and Public Limited Companies

The Concept of Distribution and Tied-Up Equity

A fundamental principle in Norwegian company law is that shareholders are not free to revert the contributed capital to themselves. This principle protects creditors, who can only claim against the company's assets.

Distribution from the company is defined in the Companies Act Section 3-6, second paragraph as "any transfer of values that directly or indirectly benefits the shareholder". This means that:

1. There must be a transfer of values

2. There must be a connection between the shareholder's holding of the share and the company's transfer

3. The transfer must directly or indirectly benefit the shareholder

According to the Companies Act Section 3-6, first paragraph, distribution from the company can only occur:

• According to the rules on dividends

• By capital reduction

• By merger or demerger

• By repayment after dissolution

This means that all other gratuitous transfers to shareholders not grounded in these rules are illegal.

Tied-Up and Free Equity

A company's equity can be divided into:

• Tied-Up Equity: Consists of share capital, reserves for unrealized gains, and reserves for valuation differences

• Free Equity: The portion of equity that exceeds the tied-up equity

Only the free equity can be used for distributions. This principle is expressed in the Companies Act Section 8-1, first paragraph, stating that the company can only distribute dividends to the extent it retains net assets that cover the company's share capital and other tied-up equity after the distribution.

Dividend Rules

Dividends are the most common form of distribution from a private limited company. For a dividend to be lawful, the following conditions must be met:

1. Free Equity: The basis for dividends can only constitute the free equity based on the company's latest approved annual accounts.

2. Deductions for dispositions before and after the balance sheet date: When calculating the dividend framework, deductions must be made for, among other things, credit and securities, treasury shares, and other dispositions that have reduced the free equity.

3. Prudent equity and liquidity: The company can only distribute dividends to the extent it retains prudent equity and liquidity after the distribution, cf. the Companies Act Section 3-4.

4. Formal Requirements: The decision on dividends is made by the general meeting based on a proposal from the board. Higher dividends than the board has proposed or agreed to cannot be decided.

An alternative option is an extraordinary dividend based on an interim balance according to the Companies Act Section 8-2a, allowing the company access to surplus without having to wait until the next annual accounts are approved.

Group Contributions

Group contributions are an alternative form of distribution within a group of companies. This allows transferring excess liquidity between group companies, both downwards, upwards, and sideways in the ownership chain. For group contributions, the same material and formal conditions apply as for dividends.

The main difference between group contributions and dividends is the tax treatment. Group contributions are deductible for the contributing company, while the recipient is taxed.

Gifts from Private Limited Companies

Companies can give gifts under certain circumstances. The Companies Act Section 8-6 regulates this as follows:

1. Occasional gifts and gifts for charitable purposes: The general meeting can decide, by ordinary majority, to give occasional gifts or gifts for charitable purposes deemed reasonable.

2. Minor gifts decided by the board: The board can give gifts for the same purposes that are of little significance relative to the company's position.

3. Other gifts: Other gifts can only be given with the consent of all shareholders and only if the gift is within the framework of the funds that can be used for distribution of dividends.

A gift in violation of these rules will be invalid.

Credit and Security Provisions

The company's ability to give credit or provide security to shareholders is regulated in the Companies Act Section 8-7. There are two fundamental conditions:

1. The disposition must be within the framework of the funds the company can use for distributing dividends.

2. Adequate security must be provided for the claim for repayment or recovery.

The justification for these restrictions is that such credit or security provisions represent a use of resources that does not promote the company's business and can expose the company to risk if the loan is not repaid or the security provision is enforced.

Company-Financed Share Acquisitions

The Companies Act Section 8-10 allows, under certain conditions, the company to provide financial assistance for the acquisition of shares in the company. This was previously prohibited, but the rules were relaxed in 2013 to give companies greater freedom to contribute to ownership and generational shifts.

For financial assistance in share acquisitions to be lawful, several cumulative conditions must be met:

1. The assistance must be within the dividend framework (free equity)

2. It must be provided on ordinary business terms and principles

3. Assistance can only be provided for the acquisition of fully paid-up shares

4. The board must perform a credit assessment and prepare a statement

5. The assistance must be approved by the general meeting with a majority as for an amendment to the articles of association

6. The board's statement must be sent to the Register of Business Enterprises

Sanctions for Illegal Distributions

Obligation to Return for Illegal Distributions

If a distribution from the company has occurred contrary to the provisions of the law, the recipient must return what was received, cf. Companies Act Section 3-7, first paragraph. Whether the recipient was in good faith is initially irrelevant.

For distributions where the rules in one of the relevant rule sets were initially followed, good faith on the part of the recipient may, however, waive the obligation to return.

Liability for Assistance

Anyone who has participated in a decision or implementation of an illegal distribution, and who knew or ought to have known that the distribution was illegal, can be held responsible for ensuring that the illegally distributed amount is returned to the company, cf. Companies Act Section 3-7, second paragraph. This can apply to board members, the CEO, auditors, shareholders, and others.

Consequences of Illegal Credit and Security Provision

If the company has given credit or provided security contrary to the rules, the disposition is invalid. Transferred funds must be returned to the company immediately. For loans, this rule is unconditional, while for security provisions, the obligation to return is limited by a good faith rule that protects the counterparty who was in good faith when the security was provided.

Agreements Contrary to the Prohibition Against Company-Financed Share Acquisitions

Agreements made in violation of the rules on company-financed share acquisitions are not binding for the company. Funds transferred from the company, or an amount equivalent to the value of the funds, must be returned immediately. Invalidity occurs regardless of the counterparty's good or bad faith.

Distributions from Partnerships

In partnerships, not only distributions within this year's profit framework, but also distributions that affect the equity can, in principle, be made if the company meeting unanimously approves it. There is, in principle, also nothing stopping distributions that impact external capital, as long as this would not obviously harm the company's or creditors' interests.

This reflects that participants in partnerships are personally responsible for the company's obligations, which reduces the need for creditor protection through distribution restrictions.

Summary

The rules on the participants' right to the company's assets balance the interest of company participants in returns against the need to protect creditors and minority shareholders. These rules are particularly extensive for private limited companies where participants have limited liability.

Key principles are:

• Only free equity can be distributed to shareholders

• Distributions must occur through legally stipulated channels (dividend, capital reduction, merger/demerger, or dissolution)

• There are strict rules for credit, security provisions, and financial assistance for share acquisitions

• Illegal distributions trigger an obligation to return and potential liability for assistance

For partnerships, the rules are significantly simpler due to participants' unlimited liability, but the principle of equality still generally applies in distributing profits among participants.